Sunday, January 22, 2012

Central banks should do some fiscal.

This paper by a professor of computer science, Russ Abbott, suggests that the Fed should have to right to alter sales taxes and payroll taxes. H/t to Scott Sumner. To download, click on the “One click download” phrase top centre. The paper is less than 1,000 words.

One advantage of this system, as the author points out (and as I pointed out here), is that implementing stimulus (or “anti-stimulus”) by monetary policies alone is distortionary: for example interest rate adjustments work only via entities that are significantly reliant on variable rate loans. (Technical problem: that link just above may take you to the end of the comments on the blog post linked to.)

In contrast, adjustments to a sales tax and/or payroll tax affects well over half of all households, and are thus less distortionary.

Politicians.

An obvious problem is that those economically illiterate politicians will balk at having some of their power removed.

However any politicians who make this objection are being illogical in that they conceded long ago that decisions on how much the economy needs speeding up or slowing down should be taken by central banks. Thus the only question is exactly how central banks should do this: monetary means alone, or monetary plus a bit of fiscal.

If politicians want to retain the right to control fiscal WITH A VIEW TO CONTROLLING STIMULUS, then they are saying the decision as to what stimulus an economy gets should be split between two bodies: central bank and a body of elected politicians. And that is PLAIN DAFT. As I pointed out here, you might as well have a car with two steering wheels one of them controlled by husband and the other by his wife in the middle of a marital breakdown.

Political neutrality.

A fault in Abbot’s proposal is that it is not politically neutral. That is, if stimulus is needed, only the private sector would be boosted under Abbot’s proposal. And that is a serious fault because it gives ammunition to the politicians who will claim their right to make political decisions is being diluted.

However, there is a very simple remedy namely to arrange for both public and private sectors to be boosted by the same percentage when stimulus is needed. To illustrate, given a need for stimulus, the central bank could cut the sales tax and/or payroll tax by enough to give an X% boost to the private sector over say the following two years. PLUS the central bank could tell politicians they can expand public sector spending by X% over the same period.

In short, the above “central banks do some fiscal” policy needn’t have ANY EFFECT WHATEVER on politicians’ control of the most basic political decisions that any country takes. These are first, what proportion of GDP is allocated to the public sector, and second, how public sector spending is split between education, the military, law enforcement, and so on.